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Is TransDigm Finally Cooling Off?

By Dan Caplinger - Aug 7, 2018 at 12:21PM

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The aerospace industry still looks hot, but there have been some signs of a slowdown.

The stock market's gains over the past decade reflect the health of the U.S. economy, and the aerospace sector has played a key role in pushing the recovery higher. The suppliers of components and systems that the industry's aircraft manufacturing giants need in order to build and deliver new planes to airlines and other customers have benefited greatly from the rising demand. And TransDigm Group (TDG -0.23%) in particular has made an impressive ascent in recent years.

Coming into Tuesday's fiscal third-quarter financial report, TransDigm investors had high hopes that the good times would continue for the aerospace supplier. Although the company kept growing, TransDigm wasn't able to deliver quite the gains that investors have come to expect, and that has some people wondering whether an end to the long boom for aerospace generally could be coming in the near future.

Blue sky with jet and contrail, along with TransDigm logo and slogan.

Image source: TransDigm Group.

TransDigm loses some lift

TransDigm Group's fiscal third-quarter results still indicated reasonably good conditions. Revenue was higher by 9% to $980.7 million, which was faster than TransDigm had seen earlier in the year, even though it fell short of the nearly 10% growth that most were looking to see. Similarly, adjusted net income of $223.2 million rose 21% from year-earlier figures, but the resulting adjusted earnings of $4.01 per share fell short of the consensus forecast of $4.07 among those following the stock.

Some of the biggest concerns from investors came from TransDigm's segment numbers. The commercial aftermarket business continued to lead the way higher for the company, posting the highest year-over-year growth in revenue. Yet those gains slowed to just 8%, barely half what TransDigm achieved three months ago. Growth in the defense business was relatively stable at 4.5%, but commercial original equipment manufacturing (OEM) only managed to pick up 1% from year-earlier levels.

Also weighing on TransDigm was the higher interest expense associated with recent acquisitions. However, cost containment elsewhere helped keep overall expenses in check. Gross margin improved slightly due to stronger sales of higher-margin proprietary products and components, and overhead expenses were up less than 5%, resulting in operating margin gains of almost a full percentage point to 27.1%. Dramatic reductions in tax rates were a big contributor to overall profit growth.

New CEO Kevin Stein, who succeeded Nick Howley last quarter, was happy with the company's results. "Our smaller sub-markets of business jets and helicopters reported strong revenue growth in the current quarter in both commercial OEM and aftermarket, an encouraging sign after pronounced weakness," Stein said. He also pointed to solid margin performance even in the wake of acquisitions that would more typically put pressure on the bottom line.

What's ahead for TransDigm?

TransDigm thinks that the future could be even brighter. In mid-July, it completed its purchase of foam, flammability testing, and acoustic solutions company Skandia, paying $84 million for the privately held company. The move further broadens TransDigm's scope in the industry, allowing it to offer an even wider range of products to manufacturers.

However, TransDigm made some mixed moves to its outlook for the full 2018 fiscal year. On one hand, the company increased its expectations for revenue, with a new range of $3.78 billion to $3.82 billion seeing a $40 million boost to its lower end. However, TransDigm also narrowed its adjusted earnings guidance toward the lower end of its previous range, with the new projection of between $17.45 to $17.77 per share representing a $0.10 rise in the bottom end but a $0.22 decline at the top.

TransDigm shareholders weren't happy with the news, and the stock lost 3% at midday following the report. A lot depends on whether TransDigm's customers continue to experience the high demand that they've seen in previous years. If anything happens to threaten the solid growth that aerospace has seen lately, then it could have a much bigger impact on TransDigm in the months and years to come.

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